The third key management accounting tool, the balance sheet, is neglected by many companies that maintain a cash flow statement and an income statement.
There are two reasons for this. First, owners confuse it with bookkeeping, which looks bulky and complicated, and they are afraid to bother with it. Second, they do not understand that only the balance sheet contains answers to a number of questions about business finances, which the other two reports cannot.
Why a management balance sheet is important and how to work with it properly, we understand with the financial director of the outsourced “Neskuchnyh Finance” Inga Adlyablina. Consult Bureau conducts management accounting for more than 100 clients from Ukraine, Russia, Kazakhstan, Belarus, and the Czech Republic.
Why you shouldn’t be afraid of a management balance sheet
“People far from finance do not understand the difference between two types of the balance sheet – management and accounting.
Accounting is the sphere of relations between business and government. In this case, a balance sheet, as well as other accounting reports, is a must. If you don’t have it or something turns out to be wrong with it, you are going to get fined. Since the balance sheet looks complicated and scary, you want to delegate it to a specialist and not remember it.
Managerial accounting is an internal tool. The items in both types of balance sheets are the same, but that’s where the similarity ends.
Unlike an accounting balance sheet, a management balance sheet is easily adapted to the realities and scale of a particular business. All the items in the accounting balance sheet which are irrelevant to you, you can safely discard from the management balance sheet”.
What questions does a management balance sheet answer?
A management balance sheet is a “photograph” of a business, which captures and reflects its financial condition at the time of compilation.
“Let’s break down point by point what questions the balance sheet alone will answer:
#1. How many dividends can be withdrawn? You’ll say, “But it’s clear from the profit and loss statement – the net profit is there.” But the profit and loss statement shows how much profit you can dispose of. But there is no information about your debts, for which you could have spent at least part of it, in the profit and loss statement. It is only in the management balance sheet.
#2. In a situation where OPU shows a good profit, but there is not much money in the account, the management balance sheet shows where it is “buried”. Usually, the profit is frozen in inventory and accounts receivable (all that is owed to you) – you received $30k, of which $10k was used to buy raw materials for the production of a new batch of goods. And for the products for $15 thousand, which has already gone to the customer, he will pay only the next month. This is why there are $5 thous. on the account, and $25 thous. is frozen: 10 in stocks and 15 in accounts receivable. Let’s use the table to show the distribution of profits by assets and liabilities on the balance sheet.
#3. How rich the company is and who actually owns it. When there is a lot of money in the accounts and the business owns real estate, vehicles, and equipment, the owner has the illusion that his company is rich.
But it also happens that all the assets were bought on credit funds, which still have to be paid back. The money on the account and in the cash register are prepayments and borrowed funds, and there is a huge hole in the owner’s equity (the company’s debts exceed the value of everything the company owns). It turns out that the business is yours only formally, but in fact at any time can go to creditors.
#4. There are no errors in the management balance sheet and cash flow statement (Cash Flow Statement). A management balance sheet consists of two parts: assets (everything the company owns) and liabilities – the liabilities of the business (at whose expense those assets were acquired). There is a golden rule – assets in the management balance sheet are always equal to liabilities. If they do not add up, look for an error or in the balance sheet itself, or in the other two reports. And it is bound to be found.”
How to implement a management balance sheet
“Implementing a management balance sheet has three key components:
- terms of sources and the report itself
Everything is simple with the items. Because they are unified and coincide with the balance sheet, we take them from there, and simply cut out everything unnecessary.
For example, the “Non-current assets” section of the balance sheet contains a lot of unnecessary stuff. Anything that is irrelevant to your business, feel free to throw out. A common situation is when you end up with only “Fixed assets”. If they are not, then you do not need this article. When they appear, for example, buy machines – then add them.
There is a “VAT” item in the balance sheet. If you don’t work with this tax, you don’t need it either. Most small business owners prefer the simplified taxation system, in which VAT is not charged.
To make it easier to work on a management balance sheet, there are operational tables which, when you implement the first report, have to be generated from scratch. Here are examples of the most common ones:
“Stock Goods/Inventory Accounting” – how many products are purchased or produced, how many raw materials are purchased, how many materials are consumed, and goods are sold. The balance of products or raw materials as of the date of the management balance sheet is reflected in its items “Goods” and “Inventories,” respectively.
“Accounts Receivable and Accounts Payable” – how much is owed to you and how much to you. If you do your reporting in Excel or Google Tab, you can automatically translate the changes in accounts payable from your DDS report into this table as you receive advances and prepayments from customers. But product sales to customers or goods and services that you receive from your counterparties will have to be entered manually. You can keep separate tables on accounts receivable and accounts payable.
“Payroll sheet” – this document from the accounting department is enough. The basic rule is that the salary accrued for the previous month, until you pay it, hangs in your accounts payable. For example, in June you accrued a salary of $20,000. As of July 1, that’s $20,000 more to your accounts payable – you owe that money to your own employees.
“Tax Accounting shows your obligations to the government. And if you have overpaid taxes, it means it owes you.
“Transaction Sheet” is a popular tool that many people use without regard to the management balance sheet. And for the balance sheet, it serves as a source of data on how much customers owe you if you have postpaid or installment sales.
Information about the balance of money on accounts and in cash is taken from the DDS report. The net profit, which is also reflected in the management balance sheet, is taken from the GBS. For this reason, the balance sheet is the last to be compiled. It will be incomplete without the finished TDS and PM&A.
As far as deadlines are concerned, I can recommend setting one date for all three major reports to be submitted to the owner. Usually from the 1st to the 5th of the new month – it allows you to collect all the reports, and gives the business owner enough time to analyze them and make management decisions.
But the tables, on the basis of which the balance sheet is formed, should be worked on daily: as soon as there is an occasion to make changes to any of them, it must be done.